I like to compare buying stocks to playing poker. In both games you are playing against other people and your success depends directly on how poorly the other people do relative to yourself. Every dollar you make must come from someone else; they are essentially zero-sum games. If you win a hand in poker, the losing players pay you. If you sell a stock for more than its worth, the seller loses the difference to you. If you fail to do either, your loss is equivalent to their gain.

Of course, there is a fundamental difference. In poker, though the house is not against you, it does tax winnings and therefor reduces the total wealth of all involved. In the stock market, businesses are involved which are fortunately not zero-sum and instead produce wealth. The wealth that the businesses produce and the amount the house takes in poker are the game’s edge. Historically the stock market has an edge of negative 10% per year, poker has an edge of around 5% per pot. Making 10% in the stock market is as easy as losing 5% in poker, you just do what everyone else does.

However, if you want to make more than the 10% you must take that money from other investors, just as if you want to make money in poker you must take it from other players. I don’t mean to ruin the whole idea that market-beating investors are amazing people that generate wealth without hurting anyone, but it just isn’t the case. Every dollar they make above 10%/year comes from the mistake of another investor. I would argue that great investors are indirectly helping the economy far more than the they are hurting the investors they take the money from, but that’s beside the point. Beating the market means beating other investors.

It’s not about finding great businesses, every company is priced to return 10%/year (because this is the perceived time value of money in the stock market due to historical averages) according to the consensus of all investors, weighted by how much money they have to invest. A great business may be able to grow earnings 40%/year, but it’s share price will always reflect a risk-adjusted consensus between all investor capital to produce an average 10%/year appreciation. Similarly, a company that will earn less in the future is priced by the same mechanism to a price that also allows it an average 10%/year appreciation. The efficiency of markets and the book ‘A Random Walk Down Wall Street‘ explain in further detail why a good company is not enough.

The only way to actually beat that 10% is if you can find businesses where the amazing wisdom of capital weighted consensus is wrong. It’s not easy either, there are trillions of dollars invested in the US stock exchange alone; you can bet that amount of money commands some of the most brilliant investing minds in the world to find those under priced businesses before you. How, then, can anyone hope to ever beat them? The same way one would beat Bobby Fischer: play him in any game but chess (Warren Buffet wisdom).

The game of billion dollar investors and successful fund managers are large companies that they can research much better than anyone else. Betting against them on such companies is not a wise idea. Betting against them at all even should be avoided. Instead, focus on a game of your own against weaker opponents. Find companies that everyone else is avoiding and you understand much better than the average investor dollar (investor weighted by amount of capital). Know something everyone else doesn’t and make large bets on it. Together, these strategies make up your edge against the market and without this edge you cannot possibly beat it.

Every time you buy or sell a stock you are making a bet that you are right and the person on the other end is wrong. Make sure you have the edge on every bet, stay away from any bet where you don’t.

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